What is the Money Factor?
The money factor is the financing cost of a monthly lease payment. The money factor is essentially the portion of the monthly payments on a lease that is allocated to the financing cost of the lease. It is similar to the interest paid on a mortgage. The money factor is typically not quoted in an APR (annual percentage rate). To convert the quoted money factor to an APR, you must multiply it by 2,400.
It should be noted that the money factor can be hard to understand because of the convention. The money factor is also known as the lease fee, lease factor, or factor. Furthermore, it holds that the larger the money factor on a lease, the larger the total lease payment will be in a month.
Another way to think of the money factor is the cost of borrowing. It is essentially the return that the lessor expects on the lease they are extending to the lessee.
The most common application of the money factor is in car leases. The lease payments made on the car include taxes, the depreciation of the car, and interest. The money factor determines the interest. The money factor on a car lease is very similar mathematically and in concept to the interest on a monthly mortgage payment; however, as mentioned above, it is quoted unconventionally.
To convert the money factor of a car lease into an understandable figure, multiply it by 2,400; it will yield the APR of the money factor and is, in essence, the car lease’s APR interest rate. For an individual applying for a car lease, demonstrating a strong credit score will decrease the money factor of the lease, thus reducing the monthly lease payments.
It is argued that the money factor is a grey area in the car lease industry, primarily because many customers do not understand the concept. It is argued that customers may not understand the direct effect on the monthly lease payments or that the money factor is quoted at 1/2400 times of an APR.
How to Calculate the Money Factor
The money factor is typically provided by a car dealership or bank in a car lease; however, it is useful to understand how it is calculated. Below is the formula to calculate the money factor:
- Sum of Monthly Finance Fees – Also known as the sum of lease charge, it is the sum of all of the monthly financing over the entire term of the lease.
- Lease Price – The price for the lease; commonly, the price for the leased car.
- Residual Value – The value of the asset after lease; typically, the value of the car after lease.
- Lease Term – In months, the length of the lease.
A numerical example of the money factor is very useful to understand the concept intuitively. Below is an example:
A lessee is leasing an old sports car for three years. The lessee and the car dealer agreed on a lease price of $50,000. Once the lease is over, the car will still be valued at $10,000. The monthly finance fees over the entire 3 years are $6,000.
Money Factor = $6,000 / [($50,000 + $10,000) * 36]
Money Factor = 0.00278
Money Factor as an APR = 0.00278 * 2400
Money Factor as an APR = 6.67%
The lease term is noted as 36 in the equation because the equation requires the lease term to be in months; thus, three years is equivalent to 36 months.
Money Factor Intuition
To achieve a lower money factor in a car lease, it is important to demonstrate a strong credit history. It can help to decrease the monthly finance fees. Also, if the car’s residual value is high, it will also decrease the money factor.
It should be noted that car lease consumers should be aware of how the money factor can impact them financially and also understand the quoting convention of the money factor to not be misled.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: